How Far Will Fed Go To Get Economy Rolling?

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The market has been marking time lately as investors await the election results and the much -anticipated Federal Reserve announcement after the Federal Open Market Committee wraps up their meeting on Wednesday.

The Fed is expected to provide a peek into its next round of quantitative easing, now considered a fait accompli. The only question seems to be how far the Fed will go to reinvigorate the economy.

But unless Republicans fail to capture the House of Representatives on Tuesday, the Fed's next move could provide market bulls with just the ammunition they need to send the bears running for the hills.

Stocks paced the carpet this week, taking the longest possible route to go nowhere. The U.S. and overseas equity markets closed flat, gold and miners were up, agriculture was up and bonds were up.

The most significant new development was the Nasdaq 100 finishing over 2,055, as it was the third weekly close above the neckline of the inverse head and shoulders bottom we've been monitoring, as shown above. The Nasdaq has crept quietly back above not just the April 2010 high but also the April 2008 high without encountering much resistance.

Shh, don't tell anyone. It'll just be our little secret. But the bear market in Nasdaq stocks is almost over. It looks like the tech-heavy index has a fairly clear shot now at 2,239, which was the top of the 2003-2007 bull cycle. Bears are likely to put up a good fight, but if that level is eclipsed you will see the mother of all short squeezes.

Of course there's a long way to go back to the all-time top in March 2000 at 4,816. But the imperfect measurement employed by technical analysts on inverse h&s bottoms puts the target for this pattern at 3,106. That would reset the clock to October, 2000.

Mostly holding the major market indexes back this week has been weak forward guidance from large banks and industrials such as Bank of AmericaCorp. (NYSE: BAC) and 3M Co.(NYSE: MMM). This is not necessarily bad in a broader sense, remember, because investors want to see companies struggle as it helps ensure that the Federal Reserve will stay the course with its apparent decision to launch a new round of quantitative easing.

The most positive news this week came from the government's job counters. The Bureau of Labor Statistics said initial jobless claims decreased 21,000 to 434,000 in the latest week, contrary to expectations for a 3,000 increase to 455,000. It amounted to the biggest two-week decline and to the lowest level since early July.

Optimists took that as a sign that the labor market is improving, while pessimists said the numbers went down because more discouraged workers left the work force. If you stop looking for work, you may recall, you are no longer counted as unemployed. Strange, but true.

The main driver of equities over the next few days will be assessments of the U.S. election and the behavior of the U.S. dollar. The market has discounted, or priced in, a new GOP majority in the House of Representatives. If the Republicans do not win a majority in the lower chamber, then there's a pretty good chance of a steep correction in share prices.

Meanwhile, late Thursday came renewed worries over European sovereign debt. According to my sources in the macro community, five-year Spanish, Greek and Portuguese credit default swaps — a type of insurance for bonds — were blowing out. As a result, the euro was sliding, which means the dollar was rising, and in turns risky assets were in danger of weakening.

Keep in mind that the dollar, euro, commodity and stock relationships that we have seen in the past two or three months are not written in stone. If only there were some immutable rule, but there is not. So as much as we would expect to see stocks slide if the dollar rises, as recently as March the dollar and U.S. stocks rose in tandem.

The bottom line: Everything but banks are in good shape heading into the last two months of the year. There is plenty that can to go wrong, but the bears appear scattered, disorganized and disheartened. Think positive.

THE BATTLE

A trader friend IM'd me late in Wednesday's session with the succinct note, "The bears suck." He did not mean that in a pejorative way, since like most veteran traders he makes money going both ways equally, like a switch-hitter in baseball, equally adept from both sides of the plate. He was making the observation that from a professional point of view, the bear team is just not taking advantage of circumstances that should allow it to press its edge. And they are giving up at the least provocation, allowing their positions to be crushed.

Remember that trading is in a lot of ways like a battle between two armies — in this case, bulls and bears, or optimists and pessimists. When one side has its front lines overrun, the other side swoops in and slaughters the retreating soldiers and takes their guns and ammo. Then they pursue, and try to hit the other side as they retreat.

It can get very ugly. We saw an extreme example of bears winning that kind of attack in late 2008 and the first ten weeks of 2009. And we have seen examples of bulls winning on this type of attack last year, and in September-October this year. But so far it looks to me as if bears have not yet given up, as we saw at the open today, and that means bulls are still in the early stages of wiping them out.

I hate to make this sound so glib, but I do think that the bulls are going to win this thing because they have the most powerful force in the markets on their side. And that is the Federal Reserve.

The Fed's ability to print money in an effort to encourage lending by banks and borrowing by businesses and consumers has virtually no checks on its scope. There are no regulators looking over the Fed's shoulders, no political entity, like the Senate or the President — nothing. Whatever Fed chief Ben Bernanke and his board of yes men decide will occur.

The Fed has given every indication that it intends to proceed with at least $500 billion in a new round of Treasury buying in an effort to push down interest rates — but just to make sure that the trade is not one-sided it sends out non-voting members of the board to make comments that make it sound as if they are opposed. This puts some doubt in market participants' minds, and leads to days like Wednesday — which could stretch into a week.

However I urge you not to succumb to angst over this money flood. It may be bad for citizens but it tends to be very positive for markets.

Institutional analyst Michael Belkin told clients in a note this morning that a round of QE amounting to $500 billion would be the equivalent, in percentage terms, of the infusion of money put in the system in 1999 to battle the suspected Y2K bug. Check out the comparisons in the chart above, which comes courtesy of Belkin.

That resulted in an absolute moon shot for the Nasdaq 100 in the last quarter of 1999 and the first quarter of 2000 as it amounted to a 21% increase in Fed credit, a truly massive amount.

Now consider that $500 billion is on the low end of the scale the Fed may have in mind, with the current upper boundary of consensus at $1.5 trillion, or a 65% increase in credit. And there are some estimates that range from $2 trillion to $4 trillion.

When you put it that way, it's really a shocking amount of money that they are talking about. Beneficiaries should run the gamut of the stock market, from large lagging tech stocks like Google Inc.(NASDAQ: GOOG) and BroadcomCorp. (NASDAQ: BRCM) to large lagging energy stocks, like ExxonMobil Corp. (NYSE: XOM).

How will we know if, instead, the bears are gaining the upper hand? It should show up in the charts as a material weakening of the advance first. Check out this chart of the March-April advance, above. You'll notice it also rose along the 13-day EMA until one day it closed below that level. Two days later it reversed back above. Then there were two more closes below, and the 13-day rate of change (ROC) sank below 0%. Five days later came the Flash Crash, and a two-month rout was on. The closes under the 13-day EMA were an early signal of the change in trend.

This is certainly a possibility, but it's very close to being the wrong time of year for a major decline. One of the most consistently positive bullish periods on the Wall Street calendar are the three days prior to election day — that's this Thursday, Friday and Monday of this week.

The bottom line is that declines like we saw Friday are likely to be good new entry points for investors and traders alike. I don't like what the Fed is doing, and you may not either, but a Big QE is more than likely going to happen — and I do not think the effect is fully discounted by the market. If it occurs, it won't be a one-way ride, but it may feel like that sometimes. Plan accordingly.

ECONOMY: THE WEEK AHEAD

Here's a quick look at the coming week's economic releases, with a big hand from the analysts at Econoday.

— All eyes are on the Fed's decision on quantitative easing Wednesday afternoon. But before the FOMC makes its decision, more news about the consumer will enter into the data mix with personal income on Monday and motor vehicle sales on Tuesday. The ISM reports on manufacturing (Monday) and non-manufacturing (Wednesday) will be added as well. Traders will have little time to catch their breath after the FOMC announcement and before Friday's employment report.

— Monday, Personal income in September will be reported. Look for small rise. Also, construction spending in September; look for a small decrease.

— Tuesday: Sales of domestic light motor vehicles in October will be reported. Look for decent advance.

— Wednesday: Factory orders for September. Look for sizable increase of around 1.7%. Also the Federal Reserve's Open Market Committee will release a statement on how it plans to use its balance sheet in a second round of quantitative easing.

— Thursday: Initial jobless claims for last week. Look for small improvement.

— Friday: Non-farm payroll employment report for October. The report in September showed a 95,000 decrease following a 57,000 decline in August. Most was government related. Look for improvement, +55,000.

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You might be right about the short term 'bullish' affects of the latest QE11 package. However, you might like to consider the following technical points: 1) There is a lack of internal strength in the S&P 500 and the Dow in that momentum is lagging even more so than just before the peaks in April. 2) The NYSE advance/decline ratio is lagging as well as the Up/Down Volume oscillators. 3) On the DSI front the bullish sentiment readings are higher than they were in April (again, just prior to the highs) on a 1, 5, 10 and 30 day basis. One other question to ponder is this: If the first round of QE was so successful, then why on earth does the Fed think that a second round is required? The fact is that it was not, and it isn't. The first round failed miserably, and the second round is only going to make the massive debt bubble in America even worse than it is now. A whole lot worse. The consequences will be nothing less than disastrous for the US economy as a whole. Japan tried the very same thing, and now they are clearly trapped in an asset bubble they simply cannot escape from. Even if, as you say the bulls win the day in the short term with the help of the Fed, in the long term where will the Fed and the bulls be when all this money has to be repaid? By all means have your party now, but eventually the debt will have to be repaid if the US is to survive in any way shape or form.

Because repayment is irrelevant. If you are using "us" and "we" and "US economy," you have been, or you will be paying the price. If you failed to learn that in the last couple of decades, you are likely to learn in the next two – unless you find yourself beyond such trivia. Who repays is relevant only to those of us who either cannot afford to escape, or who have the misfortune of having a conscience and/or a long term perspective. Of the big winners in the coming "boom," none are going to be paying for QE2 any more than any of Wall Street's pinheads have had to do a perp walk.

If you take accept my advice – play the phony boom, but keep your eye on the door, your profits under the bed, and your bunker ready. All will work out well in the end, if the Feds can't find you will the bills arrive.

I think the Fed will go all out to stimulate the economy. Even if the Republicans don't take over the house the market will still probably go up as the notion that a reinstatement of failed Republican policies would have somehow improved the economy is an illusion that will quickly fade. With interest rates so low, plenty of ammo left in the Fed's arsenal, corporate profits booming, a big chunk of the world's economy expanding and a market uptrend already in place, it appears that prices are headed higher.

Actually Allan Ewart | November 1, 2010 made a good point and it surely pertains to some investors. However, it would not be wise for me to sit on cash and be out of this coming rally. The period from March 2009 to December 2009 had money, billions of dollars of make believe money, buying in the Market to "sustain the values of the stocks" so said the Fed. During that time, the dollar inflated about 20% which made China very concerned. It was the Fed. buying American stocks. Made a profit on it too by selling them high. Said another way, if China had 2 trillion of U.S. Treasuries, it lost 200 billion on each trillion of U.S. Treasuries. Said from my choice of words, the buying or purchasing power of 400 billion was lost. But China used dollars to buy commodities like copper, iron, gold, silver, and so forth, so it kept some value by letting the money work. Better than sitting on the paper money. Had I personally just sat on Money Market Funds, etc., I would have lost 20% due to inflation or since that word is not used very much, I say lost purchasing power. If you think the buying power of the dollar is not falling, go shopping and buy some groceries. Take a trip to Europe, or Asia and see what you can buy with the dollars.

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